China coal sector:Some positives,near-term

Rising demand from power sector, truck ban from Sep 2017.

We expect stronger support for the coal price in March, a usually weak demandseason, due to the higher YoY consumption growth from IPPs. We believe thestable (instead of sequentially declining) coal price should be a positive for coalproducers, and a challenge for IPPs near-term. Another key event is that TianjinPort will have to forbid the transport of coal through toll roads into the port,effective from Sep 2017. This is part of the Beijing-Tianjin-Hebei (BTH) airpollution control measures, and should divert about 56mt of coal volume to therailways. The key question is whether the two major railways (Daqin,Shuohuang) will have enough capacity to handle the potential rise in volume.

‘Beijing-put’ support to coal price continues.

The China Rail Bureau has arranged 10 additional trains by March 2017, andanother 40 by end-1H17, i.e. about 50mtpa additional throughput in total. Thislargely balances the potential 56mt mentioned above. The government’s focuson ensuring adequate railway capacity reinforces our global team’s view thatstabilizing the coal price remains key for Beijing’s agenda, and that thegovernment could use import controls to balance the domestic market.

Strong power output growth, safety inspection ongoing.

Our China utilities team expects power demand growth to remain strong in 1Hdue to the residual effect of strong property investment in 4Q16. This should,however, slow in 2H. Recent data points (freight rate, vessels in queue, dailycoal use) also suggest strong coal demand from IPPs. On the supply side, thereare two kinds of safety inspections ongoing. The first is the inspection by theSafety Bureau before and during the ‘two sessions’, which is expected to endmid-March. The second is the self-inspection for coal miners required by thegovernment. This covers the mines in operation, under construction, and thoseplanning a restart. We believe the second inspection should delay the seasonalrestart of the small miners. Whether the coal market further tightens shoulddepend on the return of the 276-working day limit, which we expect to beselectively relaxed, especially with the QHD benchmark price now at Rmb623/t(up 7% from mid-Feb 2017).

Stock implications: positive on coal, challenging for IPPs.

The near-term tightening of the coal market should help to limit the seasonaldownside of coal price and put cost pressure on the IPPs. Our utilities teammaintains UP rating on Huaneng (902 HK). Yanzhou Coal (1171 HK, OP)should benefit the most from the strong restocking demand, given its sales aremainly mine mouth, the price for which is more sensitive to a change in demandthan for seaborne. The focus on mine mouth sale also suggests Yanzhou isimmune to the risk of rising rail costs after Tianjin Port truck ban. Long-term weexpect the company’s 25mtpa new projects to be favoured by the 13th FYP. Thisremains our top pick in the China coal sector. For China Coal (1898 HK, OP),we believe the company should be able to secure railway capacity for Daqin Railwith its position as the 2nd largest coal producer in China. Even if rail transportcost rises due to tightening capacity, this should provide a stronger cost supportto the coal price. We expect a stronger earnings recovery YoY than peers withits highest earnings sensitivity to the coal price. In our view, China Shenhua(1088 HK, N) should be well-protected from the competition for railway capacity,as the company operates the Shuohuang line. Yet, we expect less earningsrecovery for China Shenhua YoY than peers, with the positive impact of risingcoal price partially diluted by higher coal cost for the power segment.